Statistical
Portrayal of the Tax Exempt Bonds Office’s Enforcement Activities From Fiscal
Year 2002 Through Fiscal Year 2004

September 2005

Reference Number:2005-10-186

This report has cleared the Treasury
Inspector General for Tax Administration disclosure review process and
information determined to be restricted from public release has been redacted
from this document.

Web Site|http://www.tigta.gov

September 30, 2005

MEMORANDUM FOR COMMISSIONER, TAX EXEMPT AND
GOVERNMENT ENTITIES DIVISION

This report presents
the results of our review of the Tax Exempt Bonds (TEB) office’s enforcement data
for a 3-year period.The overall
objectives of this review were to review relevant statistical data of the TEB
office’s enforcement activities for Fiscal Years (FY) 2002 – 2004 and analyze the data for trends.

The TEB office’s
primary method of ensuring tax-exempt bonds are in compliance with the Internal
Revenue Code (I.R.C.) is through its Examination Program.The Program is designed to determine if bond
issuers are in compliance with the legal guidelines for tax-exempt bonds.In addition, the TEB office performs
examinations to determine if promoters of tax-exempt bonds should be penalized
under I.R.C. Section (§) 6700[1] for misconduct.

Synopsis

Although the TEB
office’s resources declined between FY 2002 and FY 2004, we determined the
number of Full-Time Equivalents (FTE)[2] applied to examination activities in theTEB office remained consistent.This higher percentage is consistent with the
Internal Revenue Service’s(IRS) commitment
to divertmore resources to the Enforcement Program areas.During the 3-year period we reviewed, the
number of examinations increased; the number of examinations that improved
compliance increased; the number of examinations on compliant bond issues
decreased but were still more than 50 percent of the examinations conducted; the
average time spent on compliant bond examinations remained the same; average
examination assessment amounts decreased; and high-risk market segment
examinations resulted in a slightly higher average assessment amount than other
examinations, but they took more than twice the average staff days to complete.

Response

We made no recommendations in this report. The Commissioner, Tax Exempt and Government
Entities (TE/GE) Division, generally agreed with our statistical portrayal and noted
that the data usefully illuminate aspects of the TEB office’s operations and
will be considered as the TEB office continues to pursue a focused, ambitious
compliance program.However, the Commissioner,
TE/GE Division, believes some statements in the report–those that seem to
equate success in compliance with dollars assessed–were misdirected and
incomplete and some conclusions may have been reached too casually.The Commissioner’s response provided examples
of additional types of data showing the TEB office’s impact on compliance,
particularly rebates collected, bonds redeemed, and revenue protected in future
years.Management’s complete response to
the draft report is included as Appendix V.

Office of Audit Comment

Our review was based on the data provided by the TEB office
during our fieldwork, and we believe our results are representative of the data
provided.While we agree the additional
types of data the Commissioner, TE/GE Division, referred to in the response are
important measures, the data were not included in the TEB office’s databases or
records provided to us.Also, it was
never intended that our analysis include all TEB office program
information.We concentrated on the TEB
office enforcement data resulting directly from the TEB office Enforcement Program.

Copies of
this report are also being sent to the IRS managers affected by the report
findings.Please
contact me at (202) 622-6510 if you have questions or Daniel R. Devlin, Assistant
Inspector General for Audit (Headquarters Operations and Exempt Organizations
Programs), at (202) 622-8500.

The Tax Exempt Bonds (TEB) office within the Tax Exempt and
Government Entities (TE/GE) Division administers the Federal tax laws
applicable to tax-exempt bonds.[3]Tax-exempt bonds include governmental
and qualified private activity certificates of debt issued by State and local
governments or by organizations acting on their behalf, such as universities
and nonprofit organizations.They are
used to finance various tax-exempt projectsthat
are of benefit to the public, such as courthouses, hospitals, airport
expansions, and highways.

The
economic benefit of tax-exempt status is a privilege the Federal Government
provides to governmental issuers.However, this economic benefit comes with a cost.The Department of the Treasury estimated that
$30 billion in Federal tax revenue would be lost for Fiscal Year (FY) 2004
alone from tax on interest earned if the bonds were taxable.

The Internal
Revenue Service (IRS) has acknowledged the need to address noncompliance for
tax-exempt bonds.For example, one of the objectives in the IRS’ FY 2005 – 2009
Strategic Plan, issued June 2004, is to deter abuse within tax-exempt and
governmental entities and misuse of such entities by third parties for tax
avoidance or other unintended purposes.In
addition, one part of the TEB office’s Enforcement Program focuses on
identifying third-party abuse and misconduct such as questionable financing
transactions involving the use of bond financing to cover current operating expenses
instead of for a tax-exempt purpose.Another part of its program involves tax promoter penalty investigations,
which may result in referring lawyers, and other professionals involved in
abuse to the IRS Office of Professional Responsibility.

Bond issuers
generally rely on attorneys specializing in tax-exempt bonds to ensure proposed
bonds comply with Federal laws and regulations.If the proceeds of the tax-exempt bonds are not used for their intended
purpose, the bonds may no longer be tax exempt, and the issuing organization
may be liable for the taxes as well as paying sanctions.[4]In rare instances, if the

tax-exempt status of the bond issuance is rescinded, the
bondholders may be required to pay tax on the interest earned.The TEB
office’s primary method of ensuring tax-exempt bonds are in compliance with the
I.R.C. is through its Examination Program.In addition, the TEB office performs examinations to determine if
promoters of tax-exempt bonds who engage in misconduct should be penalized
under Internal Revenue Code (I.R.C.) Section (§) 6700.[5]

We have several
qualifying limitations about the statistical analyses presented in this
report.We did not receive sufficient
and reliable data to complete all of our audit tests timely.TEB office management informed us during the
planning for this audit they did not have the resources to obtain and copy the
data we requested.As a result, we
received the last of the data 6 months after they were initially requested but
did not receive explanations for questionable items in the data until we
completed our review.After TEB office
management provided additional information to explain some of the analyses, we
revised the report accordingly.In
addition, the TEB office instituted procedures that prevented us from obtaining
most information, manual or electronic, directly from its source and required
all information to be forwarded to the Director, TEB, for review prior to being
sent to us.Because we could not examine
information from its source, we could not independently confirm whether all
information forwarded to us was accurate and complete.We believe our results are representative of
the data provided, but we do not have assurance the data are an accurate
reflection of all work accomplished by the TEB office.

This review
was performed at the TEB Headquarters Office in Washington, D.C.,
during the period November 2004 through July 2005.With
the exception of the scope limitations described above, the audit was
conducted in accordance with Government
Auditing Standards.Detailed information on our audit
objectives, scope, and methodology is presented in Appendix I.Major contributors to the report are listed
in Appendix II.

The TEB office was established after the TE/GE Division
became operational in FY 1999.At that
time, approximately 30 Exempt Organizations function revenue agents were
reassigned along with 2 managers to staff the new office.Because the revenue agents had only limited tax-exempt
bond experience, TEB office management spent part of the first several years
organizing the office and hiring and training new staff.TEB office management also developed programs
to provide education and outreach to their customers to help them comply with
the I.R.C., provided a program for their customers to voluntarily comply when
they identify they are out of compliance with the I.R.C., and developed a
program (Examination Program) to identify and examine customers who do not
comply to bring them into compliance.

The remainder of this report reflects the efforts of the TEB
office to enforce compliance with the I.R.C. for tax-exempt bond customers
using the Examination Program.We
identified the following trends from our analysis of TEB office datafor FYs 2002 to 2004.

Resources applied to tax-exempt bond
examination activities

According to the TE/GE Division Technical Time Reporting
System[6]
data, the number of Full-Time Equivalents (FTE)[7]
applied to examination activities in the TEB office has remained consistent the
past 3 years.In contrast, Chart 1 shows
the number of FTEs available overall to the TEB office declined over the same
period, which indicates a greater portion of the TEB office’s FTEs were used
for the Examination Program.This higher
percentage is consistent with the IRS’ commitment to divert more resources to
the Enforcement Program areas.

Chart 1 was removed due to its
size.To see Chart 1, please go to the
Adobe PDF version of the report on the TIGTA Public Web Page.

Sustaining a full staff in the enforcement area may be a
challenge.The Government Accountability
Office (GAO) presented testimony[8]
to Congress in March 2004, concluding that priorities other than enforcement,
including unbudgeted expenses, have consumed IRS budget increases and savings
over the last several years.TE/GE
Division management has indicated staffing the TEB office is difficult because
of the high level of technical expertise needed for tax-exempt bonds.Fewer employees available for the Enforcement
Program could affect the ability of TEB office management to enforce I.R.C. provisions
related to tax-exempt bonds.

Total examinations conducted

There are several different statistics that can give an
indication of the impact of the TEB office Examination Program on
compliance.One statistic is the total
number of examinations conducted each year.Chart 2 shows the TEB office closed more examinations in FY 2004
than in the prior 2 years.This was
despite the fact that FTEs for the Examination Program remained consistent for
the 3-year period.

Chart 2 was removed due to its
size.To see Chart 2, please go to the
Adobe PDF version of the report on the TIGTA Public Web Page.

Prior
to FY 2001, returns for tax-exempt bond issuances (Form 8038 series)[9]
were controlled on the IRS Non-Master File. These returns were not included on the IRS Master
File[10]
as processed returns (i.e., Transaction Code 150). In January 2001, the TEB office began
converting all the Form 8038 series returns to Master File Transaction Code 150
postings. TEB office management advised
us that, when they converted the bond issuances to the Master File and opened
examinations on the cases, they identified some issuances that contained
incorrect or invalid information, such as anincorrect
entity number or tax year.Return information
for these cases had not been verified as being correct when originally input to the Non-Master File.

In 2002, the TEB office
started deleting examinations containing incorrect or invalid information from
the AIMS by the use of Disposal Code 33 (Error Return).These accounts were reestablished on the AIMS
and Master File using correct and valid data.Because of this, we did not include in our analysis the 499 cases that
had been removed from the AIMS as “Error Returns.” We also did not verify that all the accounts
had been correctly reestablished on the Master File.However, we plan to initiate an audit in this
area in the future.

We also did not
include 15 cases that were on the AIMS and closed as “Survey After Assignment.”
No examinations were actually initiated on these cases and no staff time was
applied.

Examinations
of noncompliant bonds

Another indication of the impact of the Examination Program
is the percentage of closed cases that identified noncompliance with the I.R.C.
(i.e., change cases).We determined this
percentage significantly improved for the 3-year period, from 22 percent in FY
2002 to 43 percent in FY 2004.Chart 3
shows the number of cases where examinations identified some degree of
noncompliance (change cases) versus examinations that determined the bonds were
in compliance with the I.R.C. (no change cases).

Chart 3 was removed due to its
size.To see Chart 3, please go to the
Adobe PDF version of the report on the TIGTA Public Web Page.

These change examinations included 22 bond issuances
(4 in FY 2003 and 18 in FY 2004) for which the tax-exempt status was
rescinded.

Examinations of compliant
bonds

Although the TEB office has increased the number of
examinations where noncompliance is identified, there is still a greater volume
of examinations completed on what the IRS determines to be compliant bond
issuers.This is indicated by the number
of examinations closed on the AIMS without a change to the tax document (i.e., at
the completion of the examination, the tax documents are accepted as filed
without change).

Chart 4 reflects the percentage of examinations each year that
are closed without identifying noncompliance for that bond issuance.

Chart 4 was removed due to its
size.To see Chart 4, please go to the
Adobe PDF version of the report on the TIGTA Public Web Page.

TEB office management desires to make the best use of
limited examination resources, which would be examinations of the noncompliant
bond issues.The data indicate the
examination selection process improved in FYs 2003 and 2004, but there is aneed for further improvement.If TEB office management
can identify any common characteristics for the noncompliant versus theno change bond examinations, this could be used to
improve the process for selecting bonds with a high risk of noncompliance.

Time expended on no change examinations

Chart 5 shows the average time spent on no change cases
remained relatively stable, while the average time on noncompliant examination
cases increased in FY 2003 and decreased to FY 2002 levels in FY 2004.

Chart 5 was removed due to its
size.To see Chart 5, please go to the
Adobe PDF version of the report on the TIGTA Public Web Page.

We did not determine the reason for the significant variance
in staff hours for the examinations that identified some degree of
noncompliance or if the amount of time spent on no change cases is
appropriate.

Assessment amounts for noncompliant bonds

Another indicator of
the success of the Examination Program is the amount assessed on the
noncompliance identified during examinations.Charts 6 and 7 note the total and average assessments, respectively, for
all noncompliance identified during examinations.These do not include amounts for claims for
refund, bonds that are determined tobe taxable,
delinquent returns obtained, and changes made to related returns.

Charts 6 and 7 also do not include assessment amounts proposed
by the TEB office but appealed by the bond participant.Although the AIMS data contained the proposed
assessment amount for cases sent to the Office of Appeals for resolution, the
proposed assessments were not consistently reported in the AIMS data, so we did
not include these amounts in our analyses.

Chart 6 was removed due to its
size.To see Chart 6, please go to the
Adobe PDF version of the report on the TIGTA Public Web Page.

Chart 7:Average Assessment per Examination (FY 2002 –
FY 2004)

Chart 7 was removed due to its
size.To see Chart 7, please go to the
Adobe PDF version of the report on the TIGTA Public Web Page.

Because examination
assessments are made only on cases with noncompliance, we compared Charts 3, 6,
and 7.We observed the total number of
bonds (from Chart 3) where noncompliance was identified increased each
year.However, the average assessment
per case fluctuated for the 3 years but decreased from FY 2002 to FY 2004,
which indicates the degree of noncompliance identified during examinations was
less in FY 2004 than it was in the prior 2 years.

Source of bond examinations

In the Examination
Program, the TEB office works several different types of cases, including Form
8038 series claims for recovery of arbitrage payments,[11] information items,and
referrals.[12]Chart 8 shows the top six sources of
examinations for FY 2002 through FY 2004.

Chart 8:Sources of Examinations (FY 2002 – FY 2004)

Chart 8 was removed due to its
size.To see Chart 8, please go to the
Adobe PDF version of the report on the TIGTA Public Web Page.

The analysis indicates Regular Classification was the main
source of examination cases for all 3 years.Regular Classification is a process to determine whether cases should be
examined and the priority of their selection.The second highest source was Claims for Refund, which are examinations
of requests to refund arbitrage payments.The third highest source ofbonds for
examination was Directed Samples.Directed Samples are a selection of returns for specific Project
Initiatives.[13]

Examinations of high-risk market segments

The TEB office conducts a risk assessment process to
identify market segments of the bond population where there may be a high risk
for noncompliance.Bonds in those market
segments are then selected for examination through a sampling process. The TEB office determined for the 3-year
period, FY 2002 through FY 2004, that Solid Waste, Small Issue, and Housing
were the market segments with the highest risk for noncompliance.However, Chart 9 shows high-risk market segment examinations
were a small portion of the total examination inventory.For the 3-year period, high-risk market
segment examinations were approximately 14 percent of the total closed examinations.

Chart 9 was removed due to its
size.To see Chart 9, please go to the
Adobe PDF version of the report on the TIGTA Public Web Page.

Chart
10 shows the time spent working high-risk market segment cases compared to the
total examination time. For the 3-year
period, the high-risk market segment examination staff days were 27 percent of
the total examination staff days. Comparing
Charts 9 and 10, the high-risk market segment examinations used proportionally
more staff days. For example, the number
of high-risk market segment examinations for FY 2002 was 11 percent of the
total examinations but 23 percent (1,081/4782) of the total examination
time.Similarly, the number of high-risk
market segment examinations for FY 2004 was 13 percent of the total
examinations but 28 percent (1,597/5,669) of the total examination time.

Chart 10 was removed due to its
size.To see Chart 10, please go to the
Adobe PDF version of the report on the TIGTA Public Web Page.

Chart 16 shows the
average staff days per high-risk market segment examinations, for the 3-year
period, is more than twice the average staff days of other examinations.

Analyses of high-risk market segment examinations

Comparing Chart 9 to Chart 11, we noted high-risk market
segment examinations resulted in approximately the same proportion of total
assessment amounts when compared to other examinations.For the 3-year period FY 2002 through FY
2004, 14 percent of the total examinations were high-risk market segment
examinations, and they yielded 15 percent of the total assessment amount.However, as shown in Chart 15, high-risk
market segment examinations resulted in an 8 percent higher average assessment
than other examinations.

Chart 11 was removed due to its
size.To see Chart 11, please go to the
Adobe PDF version of the report on the TIGTA Public Web Page.

Although the TEB office identified 3 market segments as
having the highest risk of noncompliance, only 30 percent of the high-risk
market segment examinations identified noncompliance.Chart 12 shows how the 149 high-risk market
segment examinations were closed over the 3-year period (FY 2002 – FY 2004),
with the majority of the closures resulting in no change to the bond issuance.

Chart 15 was removed due to its
size.To see Chart 15, please go to the
Adobe PDF version of the report on the TIGTA Public Web Page.

Chart 16 shows the average staff days
expended per high-risk market segment examination versus the average staff days
expended per other examination cases.We noted the average staff days per high-risk
market segment case increased slightly over the 3 years of conducting these high-risk
market segment examinations. Comparing Charts 14 and 16, we noted
the majority of the examinations for all 3 high-risk market segments determined
the bonds were compliant (70 percent were closed as no change), although the
third year examinations took slightly more staff days to complete.

Chart 16 was removed due to its
size.To see Chart 16, please go to the
Adobe PDF version of the report on the TIGTA Public Web Page.

The high-risk market segment approach for selecting cases
for examination appears not to be a more effective way to identify cases with
the most potential for noncompliance.The
average assessment amounts for high-risk market segment examinations are
slightly more than the average assessment amounts for other examination
cases.However, the percentage of high-risk
market segment examinations that identified noncompliance (30 percent) is less
than the percentage of noncompliance identified in other examinations (37
percent), and the average staff days to complete examinations of high-risk
market segment cases is more than twice that of other types of examinations.

I.R.C. §6700 examinations related
to misconduct

Examinations related to I.R.C. § 6700are performed to determine if a bond promoter engaged in
misconduct(e.g., misleads or causes others to
be misleading about material matters) in promoting the issuance of a tax-exempt
bond under a specific I.R.C.sectionand, if so, whethera
penalty is warranted.I.R.C. § 6700examinations can be started after a
bond examination is underway and potential misconduct is identified or can be
opened as a new examination.If misconduct
is identified, a penalty can be assessed against the bond promoter under I.R.C. § 6700.If the level of misconduct does not warrant
an I.R.C. § 6700penalty,
a miscellaneous penalty can be assessed using the same basis for calculating
the I.R.C. § 6700 penalty (i.e., the penalty amount may be the same
for an I.R.C. § 6700 penalty and a miscellaneous penalty).

The TEB office assessed penalties under I.R.C. § 6700 on 5 cases
totaling $15.5 million from FY 2002 through FY 2004.We verified these assessments by tracing them
to the IRS Master File.In addition,
miscellaneous penalties were assessed in the amount of $29.2 million. We did not verify these miscellaneous
penalties because they are not recorded as an assessment on the bond account of
the issuer but are assessed against the bond promoter.These payments are not entered on the Master File
because they are not assessable to the taxpayer’s account but are instead
entered on a special IRS general ledger account.The payments can be manually transferred to
the Master File at the request of TEB office management. Because we could not readily trace these
payments to ensure they were properly posted to the correct account, we plan to
review this area in a future audit.

For the purpose of this report, the information below includes
all penalty amounts related to misconduct (I.R.C. § 6700 penaltiesand miscellaneous penalties).

Chart 17 shows the number of I.R.C. § 6700examinations closed each year.

Chart 17:Total I.R.C. § 6700 Examinations Closed (FY
2002 – FY 2004)

Chart 17 was removed due to its
size.To see Chart 17, please go to the
Adobe PDF version of the report on the TIGTA Public Web Page.

Chart 18 shows the number of I.R.C. § 6700 examinations
closed each year with the related assessment amounts.

Chart 18:Total I.R.C. § 6700 Assessments (FY 2002 – FY
2004)

Chart 18 was removed due to its
size.To see Chart 18, please go to the
Adobe PDF version of the report on the TIGTA Public Web Page.

Of the 79 I.R.C. § 6700examinations closed, 39 cases had assessments totaling $44,716,077 for
misconduct from FY 2002 through FY 2004.However, in FY 2002, 1 entity’s assessment totaled over $26
million.If that entity’s assessment was
removed for the purpose of comparing trends over the 3 years, the remaining assessments
for FY 2002 (approximately $8 million) would be more consistent with those
of the other 2 years.

Chart 19 shows the average misconduct assessments for each
fiscal year.The
same trend as in Chart 18 would result if the one high dollar FY 2002
assessment was removed.

Chart 19 was removed due to its
size.To see Chart 19, please go to the
Adobe PDF version of the report on the TIGTA Public Web Page.

We did not compare the average assessments from I.R.C. § 6700
examinations to the average assessments for regular bond examinations because the I.R.C. § 6700 assessments are penalties
for promoter misconduct while the regular bondexamination
assessments are for bond noncompliance with the I.R.C.

Chart 20 shows the number of I.R.C. § 6700 investigations
that resulted in a no change compared to total closures.

Chart 20 was removed due to its
size.To see Chart 20, please go to the
Adobe PDF version of the report on the TIGTA Public Web Page.

The higher no change rates in FYs 2003 and 2004 are an
indication that either the cases are not as productive as they were in FY 2002
or the method for identifying potential misconduct cases for examination needs
improvement.

Chart 21 shows the total staff days expended to work
I.R.C. § 6700 examinations increased between FY 2002 and FY 2004.Staff days included in this analysis include
all staff days expended on I.R.C. § 6700 examinations for the 3 fiscal
years (not just the 79 closed cases).Management information system limitations prevented us from identifying
time expended only on closed cases.

Chart 21 was removed due to its
size.To see Chart 21, please go to the
Adobe PDF version of the report on the TIGTA Public Web Page.

For FYs 2002 – 2004, a comparison of Charts 18 and 19 shows 49
percent (39 of 79) of the I.R.C. § 6700 examinations resulted in assessments
(in the amount of $44,716,077) or a referral to another IRS division for
further review.It is interesting to
note the percentage of I.R.C. § 6700 examinations that resulted in penalty
assessments decreased from a high of 88 percent in FY 2002 to 34 percent
in FY 2003 and 53 percent in FY 2004.Although the overall 49 percent assessment rate is higher than for
regular bond examinations (36 percent),there are
still opportunities for the TEB office to select more productive I.R.C. § 6700
examinations.

In 1993, the GAO reported (see Appendix IV for the report
findings and recommendations) the IRS did not use return information to
identify probable noncompliance and target enforcement efforts, lacked the
ability to levy appropriate sanctions and penalties to discourage abuse in the
tax-exempt bond area, and could use I.R.C.§6700 examinations to target those
responsible for noncompliance if they were involved in promoting a bond as an abusive
tax shelter.

The charts in this report indicate the TEB office is now
using the tools identified in the GAO report to improve noncompliance with the
I.R.C.However, there is room for
improvement in the TEB office’s efforts to ensure compliance for tax-exempt
bonds.With the IRS Commissioner’s
increased emphasis on compliance, there is a need for the TEB office to
reevaluate the way it uses its enforcement resources to have the biggest impact
on compliance.

The analyses in this report indicate the following:

·The number of examinations increased, but more
than one-half of the examinations are on compliant bond issues.

·Average examination assessment amounts have fluctuated
but decreased over the 3-year period of analysis.

·The market segment method of selecting high-risk
cases results in more than twice the average staff days to complete
examinations and slightly higher average assessment amounts.

·Approximately one-half of the I.R.C. § 6700
examinations and more than one-half of the regular bond examinations result in
no change.

These are indications the TEB office needs to better select
bonds for examination and for misconduct examinations under I.R.C. § 6700.Selecting cases where there is a high risk of
noncompliance may increase productivity and enable the TEB office to improve
compliance within the tax-exempt bond population.

Management’s
Response:The Commissioner,
TE/GE Division, generally agreed with our statistical portrayal and noted that
the data usefully illuminate aspects of the TEB office’s operations and will be
considered as the TEB office continues to pursue a focused, ambitious
compliance program.However, the
Commissioner, TE/GE Division, believes some statements in the report–those that
seem to equate success in compliance with dollars assessed–were misdirected and
incomplete and some conclusions may have been reached too casually.The Commissioner’s response provided examples
of additional types of data showing the TEB office’s impact on compliance,
particularly rebates collected, bonds redeemed, and revenue protected in future
years.

Office of Audit Comment:Our review was based on the data
provided by the TEB office during our fieldwork, and we believe our results are
representative of the data provided.While we agree the additional types of data the Commissioner, TE/GE
Division, referred to in the response are important measures, the data were not
included in the TEB office’s databases or records provided to us.Also, it was never intended that our analysis
include all TEB office program information.We concentrated on the TEB office enforcement data resulting directly
from the TEB office Enforcement Program.

A.Obtained Tax Exempt and Government Entities Division
Technical Time Reporting System data from the Director, TEB, for FYs 2001
through 2004 to determine the time applied to examination and Internal Revenue
Code (I.R.C.) Section (§) 6700 (2004) investigations.

B.Obtained Statistics of Income Data from the Treasury
Inspector General for Tax Administration Data Warehouse for Calendar Years 1996
through 1999 to determine the numbers of bonds issued in the various market
segments.

C.Obtained an Audit Information Management System
(AIMS)[14] extract from the Director, TEB, to identify
all examinations controlled on the AIMS since its inception.

D.Obtained quarterly field reports and Inventory
Spreadsheets from the Director, TEB, to determine the results of the enforcement
activities within the TEB office.

II.Analyzed the available data for trends in
enforcement activities.

A.Determined sources for examinations by fiscal
year.

1.Number by
referrals.

2.Number by information
item.

3.Number by Regular
Classification.

B.Determined staffing metrics by fiscal year.

1.Average hours/days
per case.

2.Average hours/days
per type of case.

C.Determined examination results by fiscal
year.

1.Number of examinations.

2.Average assessment/penalties/sanctions per
examination, as well as the range for all examinations.

3.Average
assessment/penalty/sanction per type (market segment) of examination, as well
as the range for all examinations.

4.Number/percentage
of examinations that resulted in I.R.C § 6700 referrals.

5.Number/percentage
of examinations that resulted in criminal referral (to the Internal Revenue
Service Criminal Investigation function or other government agencies).

6.Number/percentage
of cases that resulted in closing agreements.

7.Number/percentage
of cases that resulted in a discrepancy adjustment requiring revocation of tax-free
interest income to bondholders.

III.Compared the results of the TEB office market
segment analysis to examinations opened to determine if examination trends
follow the areas of highest risk identified by the market segment analysis.

·The Internal Revenue Service (IRS) does not use the
return information to spot probable noncompliance and target enforcement
efforts.

·The Expanded Bond Audit Program has pursued cases
identified through tips and other outside sources. A more proactive effort that includes reviews
of some more current bond issues would enhance the IRS’ knowledge of current
compliance problems and better position the IRS to determine whether it is
obtaining an acceptable deterrent effect from its enforcement presence.

·Revenue agents assigned to the Expanded Bond Audit
Program have not received final guidance providing current procedures to detect
noncompliance and address abuses. Current staffing and training practices,
which were established so the Expanded Bond Audit Program could investigate a
specific group of abuses, may not be appropriate for these broader efforts. Agents have limited opportunities in which to
apply their training and have not been trained on the many other tax-exempt
bond requirements they would need to know to recognize other forms of
noncompliance.

·The IRS’ tax-exempt bond efforts do not have
objectives or strategies to identify and resolve key tax-exempt bond oversight
issues.

·The basic sanction available to the IRS is to tax
interest earned by bondholders on abusive bonds. The IRS has been reluctant to use this
sanction because it punishes investors rather than responsible parties
directly, is complex to administer, and is often disproportionately severe. In about 70 cases since 1981, the IRS used a
closing agreement–a mechanism to settle various tax disputes–to negotiate a
settlement with an issuer of a bond the IRS considered noncompliant. However, according to an IRS official, such
agreements are not designed to promote voluntary compliance. For example, according to IRS officials,
closing agreements are typically much smaller than profits from the
noncompliance. Thus, they provide little
incentive to comply.Despite the IRS’
reluctance to tax interest in cases in which bonds do not comply with
tax-exemption requirements, it has recently begun considering this sanction.

·Another potential penalty, clarified to be
applicable to tax-exempt bonds in 1989, is the penalty in Internal Revenue Code
(I.R.C.) Section (§) 6700 for promoting abusive tax shelters, which would target those
responsible for noncompliance if they were involved in promoting a bond as an
abusive shelter of income for tax purposes. This penalty requires the IRS to prove that
someone intentionally promoted a bond through which investors could illegally
shelter income and avoid paying taxes. Because
the IRS has not actually tried to apply this penalty in the area of tax-exempt
bonds, it is not known how difficult it will be to prove such intent for
complex tax-exempt bond transactions.

·If
information about tax-exempt bond enforcement actions could be released, such
as information on the types of bonds the IRS has found to be abusive or the identities
of participants in abusive bonds, the market participants the IRS relies on to
ensure compliance with bond requirements could make more reasoned judgments
about tax-related compliance risks.

Recommendations

The GAO recommended
the Commissioner of the Internal Revenue Service:

·Partially
redirect existing Expanded Bond Audit Program efforts to include active testing
of current market compliance; identify and make better use of information to
detect noncompliance and direct enforcement efforts; provide final guidance for
tax-exempt bond enforcement; and reassess program staffing levels, locations,
and training needs in light of the Program’s future.

·Develop
and implement a plan to guide efforts throughout the IRS to make more effective
use of resources to promote voluntary compliance in the tax-exempt bond
industry. This plan should establish
clear objectives and coordinated, proactive strategies to achieve the
objectives; assess staff and information needs to carry out the strategies; and
set measurable goals.

·Test the
use of the I.R.C. § 6700 penalty
for promoting abusive tax shelters in tax-exempt bond enforcement.

The GAO also recommended
Congress may want to consider several options to enhance tax-exempt bond voluntary
compliance.

·First,
Congress may want to consider the adoption of other penalties for specific
kinds of noncompliance.

·Second,
Congress may want to consider whether permitting the disclosure of some tax-exempt
bond-related tax information, with appropriate safeguards, would improve
overall compliance incentives in the industry.

The response was
removed due to its size.To see the
response, please go to the Adobe PDF version of the report on the TIGTA Public
Web Page.

[1] I.R.C. §
6700 (2004) imposes a penalty for promoting an abusive tax shelter while making
a false or fraudulent misrepresentation as to any material matter or for making
a material gross valuation overstatement as to any material matter.

[2] A
measure of labor hours in which 1 FTE is equal to 8 hours multiplied by the
number of compensable days in a particular fiscal year.For FYs 2002 and 2003, 1 FTE was equal to
2,088 staff hours; for FY 2004, 1 FTE was equal to 2,096 staff hours.

[4] Sanctions
are payments intended to enforce compliance with the I.R.C.

[5] I.R.C. §
6700 (2004) imposes a penalty for promoting an abusive tax shelter while making
a false or fraudulent misrepresentation as to any material matter or for making
a material gross valuation overstatement as to any material matter.

[6] This is
a stand-alone DOS-based software application designed and developed to enable
electronic tracking and reporting of technical time.

[7] A
measure of labor hours in which 1 FTE is equal to 8 hours multiplied by the
number of compensable days in a particular fiscal year.For FYs 2002 and 2003, 1 FTE was equal to
2,088 staff hours; for FY 2004, 1 FTE was equal to 2,096 staff hours.

[10] The IRS
database that stores various types of taxpayer account information.This database includes individual, business,
and employee plans and exempt organizations data.

[11]
Arbitrage is the profit that results from investing the proceeds from
tax-exempt bonds in higher yielding taxable securities.Tax law generally requires a rebate of
arbitrage profits to the United States Department of the Treasury.

[12] A
document or other communication (e.g., telephone call) received from a source
outside the IRS that alleges potential noncompliance with the tax law.

[13] Project Initiatives are used to measure the
noncompliance of a particular market segment or TEB office return population.

[14] The
AIMS is a computer system used by the Tax Exempt and Government Entities
Division to control returns, input assessment/adjustments to the Master File,
and provide management information reports.The Master File is the Internal Revenue Service database that stores
various types of taxpayer account information and including individual,
business, and employee plans and exempt organizations data.